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Financial Reporting Impacts of Tax Reform

The tax legislation signed into law by President Trump is expected to have significant and immediate financial reporting impacts on organizations.* Under ASC 740, the accounting standard related to income taxes, the new legislation’s effects are generally recognized upon enactment, which for federal legislation is December 22, 2017—the date President Trump signed the bill into law—with certain prospectively effective provisions recognized in the reporting period they become effective.

Steve Kimble

“This legislation is far-reaching and complex. The enactment of new tax law in the closing days of 2017 presented a major challenge for publicly traded companies that are required to account for and disclose the effects of a change in tax law in the period of enactment,” notes Steve Kimble, chairman and CEO, Deloitte Tax LLP.

The SEC provided guidance to address situations where the accounting for the new legislation is incomplete—and allow work to continue into 2018—by establishing a “measurement period” for companies to update their estimates and complete the accounting requirements. The SEC also made clear that “in no circumstances should the measurement period extend beyond one year from the enactment date” and expects that during this time entities will be acting in good faith to complete the accounting.

The guidance follows an implementation approach whereby organizations would follow something similar to the measurement period in a business combination. More specifically, an organization would recognize those matters for which the accounting can be completed, as might be the case for the effect of rate changes on deferred tax assets and deferred tax liabilities.

Rochelle Kleczynski

“In addition, under the SEC guidance, for those matters that have not been completed, the organization would recognize provisional amounts and then adjust them over time as more information becomes available, along with robust disclosures,” adds Rochelle Kleczynski, partner and National Tax Reform leader, Deloitte Tax LLP.

Tax Law Changes with Significant Financial Statement Impact

Deloitte expects the more significant impacts of the new legislation to include the following:

—Deferred tax assets and deferred tax liabilities (DTAs and DTLs). Impacts include those related to items initially recorded through other comprehensive income and shareholders’ equity. DTAs and DTLs will need to be remeasured for the impact of the corporate rate reduction, and any adjustments will be included in income from continuing operations for the period that includes the enactment date. Note, organizations issuing under International Financial Reporting Standards may need to go through another exercise to identify where the rate change impacts on DTAs and DTLs are recorded.

Vickie Carr

—Blended tax rate. For a fiscal-year-end organization, a blended tax rate will apply to the taxable year that includes the enactment date. Accordingly, deferred taxes as of the enactment date for those temporary differences that are expected to reverse in the current fiscal year should be remeasured to the applicable blended tax rate; those expected to reverse in future years should be remeasured to the new 21% statutory rate. The effect of the remeasurement is recorded in the period of enactment.

—Recognition of aforeign subsidiary liability. An entity that historically asserted that it is indefinitely reinvested in the outside basis difference in a foreign subsidiary or foreign corporate joint venture—that is essentially permanent in duration—will likely be required to recognize a liability based on the provision, mandating a deemed repatriation of foreign earnings and profits.

Entities that had not previously determined that they were indefinitely reinvested in the outside basis difference in a foreign investment, and were hence providing deferred tax liabilities, will likely need to remeasure such deferred tax liabilities. That is because the deemed repatriation will close the outside basis difference, generally obviating the need for the deferred tax liability. In addition, tax due as a result of this provision will likely be different than the tax liability that would have been due if the outside basis difference reversed under prior law.

Paul Vitola

“Organizations contemplating changing their assertion about being indefinitely reinvested should consider not only U.S. tax with regard to the repatriation, but whether the repatriation might trigger withholding taxes as the cash makes its way up the system to the U.S.,” observes Paul Vitola, partner, Deloitte Tax LLP. However, Mr. Vitola notes that, “If an organization does not assert it has indefinitely reinvested, it likely will need to accrue for those withholding taxes as the earnings of the foreign subsidiaries accrue.”

—Income inclusion and anti-base erosion provisions. A U.S. organization may experience an increase in U.S. tax with respect to income earned by foreign subsidiaries and payments made to foreign affiliates. That is, certain global intangible low-taxed income (GILTI) will be currently taxable and payments to related foreign parties may give rise to U.S. tax under the Base Erosion and Anti-Abuse Tax (BEAT). These provisions could impact an organization’s prospective effective tax rate. The entity will need to consider whether and how U.S. deferred taxes should be recorded if it expects to have a taxable income inclusion under the GILTI provision or have income subject to the new BEAT provisions.

Robert Tache

“GILTI is a new category of income in which the income of foreign subsidiaries—controlled foreign corporations—is subject to immediate U.S. taxation,” notes Robert Tache, partner, Deloitte Tax LLP. “GILTI allows these subsidiaries to earn a certain amount of income return on their tangible personal property with the excess subject to U.S. taxation,” he adds.

—Tax credits. Several provisions in the new law either eliminate or limit deductions and tax credits (e.g., interest expense limitations, modifications to net operating losses, loss of business deductions and credits) that could unfavorably affect an organization’s effective tax rate and negatively impact earnings. These provisions, as well as others, could also affect valuation allowance analyses and related disclosures.

—Transition tax/deemed repatriation. The Act generally requires a U.S. shareholder owning at least 10% of the vote of a foreign subsidiary to be taxed in the U.S. on the previously unrepatriated earnings of such foreign subsidiary, subject to certain specific tax rules. This income is to be reported as of the foreign subsidiary’s last tax year beginning before 2018, and is taxed at one of two rates: (1) 15.5% for earnings held as cash or cash equivalents; and (2) 8% for all other earnings.

To the extent potential income tax reform could materially affect the company or its business, SEC registrants should also consider possible disclosure requirements under the Risk Factors and Management’s Discussion and Analysis sections of their annual regulatory filings.

For example, of more than 5,000 tax, finance and business professionals polled, more than one-quarter consider quantifying the financial statement impact for the period ending December 31, 2017, the most critical action following tax reform.

ENLARGE

“Just slightly more than a third of more than 4,400 tax, finance and business professionals polled during another webcast feel prepared or somewhat prepared to comply with the financial statement reporting requirements,” says Vickie Carr, partner, Deloitte Tax LLP.

ENLARGE

“There are many financial reporting issues emerging from the new tax legislation that organizations will have to address—from GILTI and BEAT computations and calculating limitations on business expense interests to knowing foreign rate pools and thinking through whether withholding taxes apply,” notes Ms. Carr. “The initial focus for organizations, however, may be to understand cash requirements and how they affect assertions, as well as determining the company’s level of readiness to address new tax considerations.”

* H.R. 1/Public Law 115-97, “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.”

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About Deloitte Insights

Deloitte’s Insights for C-suite executives and board members provide information and resources to help address the challenges of managing risk for both value creation and protection, as well as increasing compliance requirements.